Soaring sterling: these trusts could cash in on the election

Analysts at Stifel highlight the trusts that could see a reversal in fortunes if sterling continues to strengthen.

A stronger pound could spell a reversal in fortunes for the top performing investment trusts over the past year.

On Tuesday, the prime minister surprised many by calling for a general election on 8 June, claiming it was the only way to 'guarantee certainty and stability for the years ahead’. The pound has since risen by more than 2.5% on hopes that May can secure a larger parliamentary majority that will help her to secure a ‘softer Brexit’ deal.

During 2016, sterling weakness that followed the Brexit vote provided a tailwind for investment trusts with dollar exposure or a heavy allocation to companies with international earnings. This is because a weak pound boosts the value of overseas investments, which can be good for global funds.

RIT Capital Partners (RCP) is a prime example. It saw its net asset value rise by 12.1% in 2016, driven by a 9.6% currency gain.

If the pundits are to be believed and the Conservatives achieve a stronger working majority, sterling is expected to strengthen further. In this environment, which trusts stand to benefit?

Peter Lowman, chief investment officer at Investment Quorum, suggested that some of the trusts and investment companies that were hit the hardest following the Brexit vote could see a rebound.

These funds were penalised by investors on account of their high sterling exposure or bias towards domestically-focused companies in the small and 'mid-cap' space. However if we see a stronger pound, this could curb the rate of growth in overseas investments when converted into sterling.

‘If you are looking for opportunities now, I would probably focus on fund managers and funds that have a deeper exposure to domestics or companies that might benefit from importing. This is because a stronger pound will benefit importers more than exporters,’ Lowman explained.

Trust picks

Lowman highlighted the Schroder UK Mid Cap (SCP) investment trust as one to watch. Trading on an 18.1% discount to NAV, well below a sector average of 11%, the trust has had a tough few years. Its share price has risen by only 6.7% over the past three years, which compares to a sector average of 29.1%. Nevertheless, Lowman suggests a reversal in fortunes could be in store for manager Andy Brough.

‘There is a very good manager running the fund who has a lot of experience in mid and small cap,’ he added.

Further down the market cap scale, Lowman suggested Henderson Smaller Companies (HSL) and Standard Life UK Smaller Companies (SLS) as potential beneficiaries of sterling strength. They are currently trading on discounts to NAV of 15.1% and 6.3% respectively.

The chief investment officer said the announcement of a snap general election and sterling’s subsequent rise provided investors with a prime opportunity to review the stock allocations of underlying funds held in portfolios. If you discover a concentration in a certain market cap, sector or style, it could be time to make changes to the portfolio

Although Lowman agreed that sterling would strengthen if the Conservatives achieved a landslide, he noted there would be bumps along the way as the UK navigates an exit from the European Union. This will create further volatility for sterling.

He pointed out that investors opting to close short positions drove much of sterling’s rise on Tuesday, so this could be considered a one-off hit.

‘There is no guarantee that sterling has recovered or is on a recovery pattern, it is just that [Tuesday's] news made sure that the guys with shorts on sterling got concerned and closed their short positions quite quickly, as nobody understands what might happen over the next few weeks,’ he added.

It is difficult to ascertain exactly how much exposure global investment trusts have to sterling. There is no official way of doing this, but analysts at Stifel have had a go by ranking the main funds in the AIC’s global, global equity income and flexible sectors by the amount they invest in the UK and how they approach currency hedging (see table below).

Analysts Ian Scouller and Maarten Freeriks noted that infrastructure and renewable energy funds were also worth considering during times of market volatility because they offered a low correlation to shares.

‘However, it is worth noting that some of these funds do have significant non-sterling assets. For example, in the case of BBGI, sterling weakness added circa 12p or circa 10% to NAV in 2016,’ the analysts explained.

Derivatives may be used for the purpose of income enhancement and portfolio management covering tactical asset allocation and risk mitigation including protection against currency risks within strict limits.

Manage currency exposure centrally through an overlay approach through the use of currency forwards, borrowings and options. Overall, currency impact contributed 9.6% to total return over year to 31/12/2016.

Source: Stifel

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